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Cryptocurrency Taxation: Understanding the Basics

Cryptocurrency taxation - Understanding the basics

A crypto asset is a digital representation of value that is not issued by a central bank, but is traded, transferred and stored electronically by natural and legal persons for the purpose of payment, investment and other forms of utility, and applies cryptography techniques in the underlying technology

Because financial technology (fintech) is relatively new and has developed faster than legislative processes, and because the nuances of blockchain applications are varied, Fintech and Crypto Law cover a broad range of regulations, many of which were formulated before its existence.  As such, it covers laws and regulations in the fields of financial services, ITC, exchange control, and tax, and involves keeping abreast of these regulations as they change to adapt to it.

Blockchain technology itself is advancing in major financial services institutions such as banks and insurance companies, and the regulatory implications cross over a broad area of law. In addition, crypto assets are deemed “financial products” under the applicable financial services regulations, imposing potential licensing obligations on those who work in the cryptocurrency investment space.

How does crypto get taxed in South Africa?

Cryptocurrency Law and Regulations are rapidly evolving in South Africa and globally. With recent regulatory changes, crypto asset service providers will have to be regarded as accountable institutions under the Financial Intelligence Centre Act, 2001 (“FICA”) and accordingly will have statutory cash reporting and monitoring obligations. In addition, crypto assets will be declared “financial products” under the Financial Advisory and Intermediary Services Act, 2002 (“FAIS”) requiring crypto asset service providers to register for a financial services provider license under the FAIS Act. With the new Conduct of Financial Institutions Bill which was expected to come into effect in 2023, the expectation is that crypto assets will potentially have their own set of regulations that will apply exclusively to them.

The South African Revenue Services (SARS) currently taxes individuals on their cryptocurrency investments in the form of capital gains tax. We expect further developments in crypto tax law in the short term with respect to reforms to the application of foreign exchange controls on the export and import of cryptocurrency to and from South Africa.  There is also an indication of possible impending investment-related taxes on cryptocurrency funds.  

Basics of Cryptocurrency Taxation

In South Africa, cryptocurrency is treated as both income (taxed on the revenue account as “gross income”) or taxed as capital gains tax depending on whether a receipt is revenue or capital in nature. Taxpayers are also entitled to claim expenses associated with crypto assets accruals or receipts, provided such expenditure is incurred in the production of the taxpayer’s income and for purposes of trade. Base cost adjustments can also be made if the receipt is treated as Capital Gains Tax (CGT).

The SARS website has the following to say with regards to taxation of crypto assets:

Following normal income tax rules, income received or accrued from crypto assets transactions can be taxed on a revenue account under “gross income”.

Alternatively, such gains may be regarded as capital in nature, as spelled out in the Eighth Schedule to the Act for taxation under the Capital Gains Tax (CGT) paradigm. Determination of whether an accrual or receipt is revenue or capital in nature is tested under existing jurisprudence (of which there is no shortage).

Taxpayers are also entitled to claim expenses associated with crypto assets accruals or receipts, provided such expenditure is incurred in the production of the taxpayer’s income and for purposes of trade.

Base cost adjustments can also be made if falling within the CGT paradigm. Gains or losses in relation to crypto-assets can broadly be categorized with reference to three types of scenarios, each of which potentially gives rise to distinct tax consequences:

  • Crypto assets can be acquired through so-called “mining”. Mining is conducted by the verification of transactions in a computer-generated public ledger, achieved through the solving of complex computer algorithms.
  • Investors can exchange local currency for a crypto asset (or vice versa) by using crypto assets exchanges, which are essentially markets for crypto assets, or through private transactions.
  • Goods or services can be exchanged for crypto assets. This transaction is regarded as a barter transaction. Therefore the normal barter transaction rules apply. SARS

International Considerations

Cryptocurrency tax regulations vary widely from one country to another, and they continue to evolve as governments grapple with the challenges of taxing a relatively new and rapidly changing asset class. Technopedia lays out  the complexities of international crypto tax obligations: 

Investors are required to pay taxes on crypto gains in most countries around the world, and failure to pay appropriate taxes can result in back taxes and fines. The rules for crypto taxation are complex and vary by country. In general, profits from crypto are taxed as capital gains, income, or both. 

The following are some general factors that need to be considered with regard to international cryptocurrency tax regulations.

  1. Tax Classification: Different countries classify cryptocurrencies differently for tax purposes. Some treat them as property, others as currency, and still others as commodities. The classification can have significant implications for how they are taxed. In South Africa, for instance,  income received or accrued from crypto assets transactions is taxed under “gross income”.
  2. Taxable Events: Most countries tax cryptocurrency transactions when certain events occur, such as buying, selling, trading, or mining. The specific events that trigger taxation can vary, so it’s essential to understand your country’s rules.
  3. Capital Gains Tax: Many countries tax the capital gains realized from the sale or exchange of cryptocurrencies. The tax rate for capital gains may depend on factors like the holding period and the individual’s overall income.
  4. Income Tax: Cryptocurrency gains might be considered regular income, especially if you are engaged in cryptocurrency trading or mining as a business. This can result in a higher tax rate.
  5. Mining Taxation: Cryptocurrency mining is taxed differently in various countries. Some treat mined coins as income, while others consider them to be capital gains.
  6. Reporting Requirements: Several countries require individuals to report their cryptocurrency holdings and transactions on their tax returns. Failure to report accurately can result in penalties, and it remains the individual’s responsibility to educate themselves in this regard.
  7. Anti-Money Laundering (AML) and Know Your Customer (KYC) Regulations: Internationally, governments are increasingly implementing AML and KYC regulations for cryptocurrency exchanges, which can have an impact on tax reporting.
  8. Gift and Inheritance Tax: Transferring cryptocurrencies as gifts or as part of an inheritance may be subject to gift or inheritance tax.
  9. International Transactions: If you engage in international cryptocurrency transactions, you may face additional tax considerations, such as withholding taxes or reporting requirements in both your home country and the country of the counterparty.
  10. Tax Reporting Software: Some countries have specific reporting requirements for cryptocurrency transactions. Using tax reporting software that is compliant with your country’s regulations can simplify the process.
  11. Tax Treaties: Consider if your country has tax treaties with other nations that could affect the taxation of cross-border cryptocurrency transactions.
  12. Regulatory Changes: Cryptocurrency regulations are continuously evolving. Stay informed about changes in tax laws and regulations in your country and globally, or consult with legal experts on this matter.
  13. Consulting a Tax Professional: Due to the complexity of cryptocurrency taxation, it’s advisable to consult with a tax professional or legal expert who is knowledgeable about cryptocurrency tax laws in your jurisdiction

Caveat

Caveat’s Fintech and Crypto Law team is multi-disciplinary and includes financial services, tax, and technology law experts, which enables our team to provide appropriate advice to cryptocurrency brokers, advisors, exchanges, and platforms in this developing landscape.

Caveat is able to assist fintech providers with input on the following:

  • Blockchain;
  • Cryptocurrency;
  • Crowdfunding;
  • Decentralized Finance (DeFi);
  • Decentralized Autonomous Organisations (DAOs);
  • Non Fungible Tokens (NFTs)
  • Financial Services Regulation;
  • Initial Coin Offerings (ICOs);
  • Payment services;
  • RegTech; and
  • Smart contracts.

In the fintech law and policy space, we also provide regulatory advice, legal opinions, and drafting of agreements in compliance with the regulatory framework currently applicable. 

The financial technology law and regulatory landscape is constantly evolving and could present first-mover fintech opportunities for those who keep up-to-date with these developments, and we advise crypto asset service providers to seek legal advice on charting their compliance strategy with these new regulations. Reach out to us to discuss your crypto tax obligations.

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